World Bank demanding 25 per cent devaluation of rupee sparks off controversy

World Bank demanding 25 per cent devaluation of rupee sparks off controversy

Traditionally, devaluation has been a dirty word in India, especially after the disastrous experience with a 1966 devaluation of the rupee.

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T.N Ninan

Palakunnathu G Mathai

June 15, 1987

ISSUE DATE: June 15, 1987

UPDATED: January 7, 2014 17:33 IST

Six years ago, the International Monetary Fund (IMF), while negotiating the grant of a $5 billion (now Rs 6,435 crore) loan to India, had suggested that the Government follow a "realistic exchange rate policy" for the rupee. Since that time, the rupee has lost 40 per cent of its value against both the dollar and the deutschmark, 10 per cent against the pound, nearly 60 per cent against the yen, and 15 per cent against the French franc.

Even as government economists argued that this 'devaluation' had been unavoidable and was delivering results (in terms of increased exports), reports last fortnight about the World Bank demanding a further 25 per cent devaluation sparked off another controversy.

Traditionally, devaluation has been a dirty word in India, especially after the disastrous experience with a 1966 devaluation of the rupee (which was done under World Bank pressure). And the Government itself has devalued the rupee steadily over six years, not overnight as in 1966. But however carefully the rupee's external value has been reduced, the devaluation issue was pushed firmly to the forefront last fortnight, with opinion divided on the me; its of what has already been done, and what needs to be done in the future.

Any devaluation of a country's currency makes its exports cheaper abroad, and imports more expensive at home. Logically, exports are supposed to get a boost, and imports to come down. But critics argued that the country's trade deficit this year would be about the same as a few years ago (more than Rs 5,000 crore), even as government spokesmen said the policy was beginning to yield results now, with exports picking up.

A government economist pointed out that India's rivals in export markets had, in fact, devalued their currencies even more, so that they gained in competitiveness against the rupee. The examples that were cited were of Bangladesh (which is scoring in jute), Hong Kong (a rival in garments), and South Korea (in construction and engineering goods). Compared to 1979, even France and West Germany have devalued more than India, he pointed out.

"We shouldn't treat the rupee's exchange value like virginity, as something that cannot be touched." Another economist argued that India has been having a higher level of inflation than several other countries, and that if Indian exports were not to get out-priced as a result, some degree of devaluation was unavoidable on a continuing basis.

That was logical, and several exporters were enthusiastic votaries of what the Government had done. Said Jatin Mehta, chairman of the Gem and Jewellery Export Promotion Council: "You get better value for your exports, and the rise in our exports last year was partly because the rupee was devalued." But devaluation is not without its costs, and the critics highlight this, arguing that the Government policy has not delivered results.

A lower value for the rupee is meant to make imports more expensive, and thereby discourage imports. But, said one dissenting Planning Commission economist: "The problem is that most of our imports are of bulk items like oil and fertilisers, which are essential. So they will be imported anyway, irrespective of the price. And because they get more expensive, they result in inflation at home."

On other counts too, the results so far have been mixed. Devaluation and the IMF loan were part of a larger strategy to tackle India's balance of payments problem with a liberalised policy package. But the latest confidential forecasts show that the trade deficit (after dipping last year because of lower oil prices) will keep increasing for the next decade.

Loans to service this deficit have to be repaid, and the debt servicing burden has gone up from barely 8 per cent of foreign exchange earnings five years ago to around 24 per cent this year - well above the 20 per cent danger mark.

In the business world, meanwhile, opinion seemed to be mostly critical of the devaluation. Inevitably, companies complained of higher costs in a host of areas (ranging from component imports to royalty and know how payments), warned of increased burdens in repaying foreign loans, and fretted about the uncertainties that have flowed from sharp and unexpected changes in the rupee's exchange rate.

"The authorities are devaluing the rupee more than necessary."R. Seshasayee, executive director, finance, Ashok Leyland

A Government economist described all this as "the initially bitter taste that is the hallmark of any good medicine", but there was no getting away from the problems that corporate executives were faced with.

Several companies which have been affected by the bigger import bills (like the light commercial vehicle manufacturers) have been screaming in protest. Said Eicher Goodearth Chief Executive Subodh Bhargava: "Since September 1985, the cost of our component imports has gone up by Rs 75,000. Of this, Rs 70,000 is because the rupee has lost against the yen."

Vehicle costs have gone through the roof, raising the break-even point in capacity utilisation (in Eicher's case this went up from 40 per cent to 60 per cent in the last six months), while the market has crashed. Another sufferer was Karnataka Ball Bearings, whose Rs 12-crore expansion project has ended up costing Rs 24 crore because the rupee has been devalued against the yen as well as the mark.

Said the company's Managing Director Jayant Mehta: "Our liability has gone up. This is a no-win situation." For Maruti Udyog, the rupee devaluation has pushed up the project cost, in terms of foreign exchange, from Rs 89 crore to Rs 110 crore. Managing Director R.C. Bhargava says component import costs in turn have gone up by 67 percent compared to 1982.

"That's pretty stiff." said Bhargava. Added Pradeep Saxena, vice-president of American Express: "The devaluation policy is damaging industry more than it is helping exports."

"The rise in exports last year was because the rupee was devalued."Jatin Mehta chairman, Gem and Jewellery Export Promotion Council

Meanwhile, each dollar of repayment has to be earned with more rupees now than before. For instance, the National Thermal Power Corporation finds that because of t!;e rupee losing ground vis-a-vis the pound, its cost of servicing a loan taken from Britain has already gone up by Rs 55 crore. Said Finance Director P.S. Bami:

"This means our project cost will go up, and because we have to recover costs, the electricity tariff will go up." Added M.K. Jhawer, managing director of Usha Telehoist (which finds its raw material imports costing more as the yen has risen in value): "In certain items, when you have no alternative but to import, you are in a very tight corner."

Even those who were once in favour of devaluation now feel that enough is enough. Abid Hussain, member of the Planning Commission and the author of the 1983 proposal for an 'aggressive'exchange rate policy, argued last fortnight that devaluation of the rupee had been taken far enough, that it wouldn't help in today's difficult trade climate, and that "quality and effective marketing are far more important factors for promoting Indian exports. The concept of devaluation has been devalued".

His views were echoed by R. Seshasayee, executive director of Ashok Leyland, who said: "The authorities are getting a little paranoid and devaluing the rupee far more than necessary. It will help promote some part of India's exports, but the price advantage may not be significant in other commodities." In areas like computer software or project exports, he added, marketing was far more important.

Even though devaluation has more critics than votaries, the policy has clearly helped in many cases. Eicher has been able to export profitably to Bangladesh and West Germany, while several companies have been forced to speed up their indigenisation programmes and cut down on their imports. And, with import values going up in rupee terms, the Government has also earned more from customs duties (which are usually charged ad valorem).

Nevertheless, even pro-devaluation experts felt that the rupee was no w reaching its proper level. Argued foreign exchange consultant A.V. Rajwade: "The devaluation over the last three or four years was aimed at reaching the real exchange rate; from now, changes will be determined by relative inflation in India and outside." That runs counter to the latest World Bank prescription, but it may well be the Government view also, for the rupee has held reasonably steady over the last few months.

And as a government economist said: "We have drastically reduced the difference between the official price of the dollar and the black-market price. So we are roughly at the level where we should be." But the next few months will show whether the World Bank has been able to convince the Government that a few more doses of admittedly bitter medicine are called for.

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